Unpacking "Impact Investment" – What It Is and Why It’s Relevant

Quick forward: new initiatives, in particular since 2007, have emerged to mitigate risks in investment while also leading to a significant and measurable improvement in the livelihoods of poor and disadvantaged women and men. Acclaimed as a “new frontier” in development finance, a generation of private sector enterprises and individuals believes impact investment can be used for tangible development benefits (social, economic and environment), as well as financial returns. Only in 2015, more than 35 billion USD was spent on impact investments.

In this blog post, we try to unpack what impact investment entails and look into its relevance for sustainably financing development initiatives.

The new buzz word of investing?

The 2015 Addis Ababa Action Agenda considers development finance as a policy objective and calls on the UN Member States to continue to build on recent progress on mobilising resources. The Agenda includes a package of measures aimed at strengthening access to finance for micro, small and medium-sized enterprises, including through the use of development banks and innovative instruments.

Impact investing is a subset of Socially Responsible Investing (“SRI”) and considers environmental, social and corporate governance (“ESG”) criteria to generate long-term competitive financial returns and positive societal impacts. However, SRI and impact investing are different. SRI has traditionally employed negative screens to select companies whose activities “do no harm,” and engaged in shareholder activism to change corporate behaviour perceived as detrimental to society. Complementary to SRI, impact investing builds on the fundamentals of exclusionary, positive and ESG screens to deploy capital in profitable companies that intentionally identify and seek positive social and/or environmental benefits.

Impact investment’s structure is made of “a strategic use of development finance and philanthropic funds to mobilise private capital flows to emerging and frontier markets," [1] known as “blended finance”. It seeks to generate positive impacts for both investors and communities; the investments are made into companies, organisations, and financial institutions (e.g. microfinance institutions, community development finance, and other types of financial institutions), usually in both emerging and developing markets.

Relevance for financing development  

The UN estimates the annual cost of meeting the Sustainable Development Goals (SDGs) globally in the 5 trillion−7 trillion USD range. Actual funding shows an annual gap of 2.5 trillion USD. Investments to achieve the development goals for 2030 require the mobilisation of billions of dollars, and these transformations will only materialise through public-private partnerships. Therefore, greater roles for the implementation of the SDGs exist for financial institutions and providers, which have the potential to stimulate positive changes at scale. The Global Impact Investing Network (GIIN) has made a clear appeal to investors: “if the financial sector does not focus on redirecting at least part of its assets to impact investments, the SDGs will be at risk of failing”.

Most importantly, impact investment has the potential for making relevant and quality financial products and services available to some 2.7 billion adults, constituting almost 70 percent of the population in developing economies, who lack access to and use of formal financial products and services. The foremost challenge has been to ensure that they have access to and good use (usage intensity) of suitable financial products and services that meet their source of livelihoods, as well as multiple risks and limited mitigation strategies.

Realising the potentials of impact investment also requires shifting the focus from a simple demand-supply transaction, as has been the case in microfinance, to a broader “financial ecosystem” to enable efforts to better understand the root causes for financial exclusions of poor and disadvantaged women and men. Often supply-demand transactions occur under or are influenced by other functions (support or service markets) such as training, coordination and information, research and development, infrastructure, and advocacy. Transactions are also mediated by rules and regulations such as users’ protection, financial supervision/regulation, and informal norms and values including local power structures.

Beyond the “moral imperative”: the business case for impact investment

The impact investing community might question the ability of development organisations to understand their business models and analyse investments and facilitate deals. Experience and research have shown that impact investment firms are aiming to invest in developing country markets, but they lack good knowledge of the local environment, leading to a decrease in investor confidence and capital due to high risks. This is where development organisations should aim to intervene – investment firms need to make thoughtful decisions to minimise their risks while contributing to development goals (social, economic and environmental).

Supplementary actions, at least initially, are necessary to ensure achieving development goals through better investment and inclusion of poor and disadvantaged women and men. Yet a pure “moral imperative” argument may not necessarily contribute to sustainable and scalable impacts through attracting investment from potential private sector actors. As stressed by the Addis Ababa Action Agenda for financing development, it is highly important that efforts for financing development are aligned with private sector incentives and capacities to make an appealing offer to businesses and articulate clearly what the “value proposition” is for achieving both development goals and financial returns.

The private sector, including financial institutions, financial markets infrastructure providers, and larger firms accounts for the bulk of impact financing. Greater sustainability and ultimately scale of results come through encouraging behavioural changes among those with institutional permanence. This means, initiatives for impact investment will require facilitating the development and introduction of innovative ideas and business models, services, or advocacy for changes to policies and regulations.

Emerging practices

Survey data from the International Non-Governmental Organizations (INGOs) Impact Investing Network [2] showed that almost 60% of INGOs are actively engaged or piloting approaches exploring how to incorporate impact investing into their programmes and strategies. As a result, development organisations are playing multiple roles, including making impact investments through direct and indirect means and across several different asset types; receiving impact investments; offering various forms of technical assistance to support different players; and building the impact investing ecosystem.

More than 90% [3] of INGOs provide technical assistance to social entrepreneurs on topics such as how to write a business plan; build and run an enterprise; attract investment; and take businesses to scale. Some are leveraging local networks to identify promising entrepreneurs. Others are assessing and identifying which programmes in their portfolio can benefit from impact investments. Another approach is to explore joint ventures (funds, platforms, and partnerships with peer organisations or impact investors) to help source and share investments. A fully formed concept for where investments will be made and how a development organisation will find them is a key consideration shaping initial strategy development.

Main takeaways

Development organisations are becoming a key part of facilitating impact investing “ecosystem” for all the reasons mentioned above. As part of this facilitation role, it is important that development organisations avoid replacing market functions or displacing existing actors and creating parallel mechanisms by paying attention to establishing a clear vision of sustainable outcomes during the design (and implementation) of impact investment initiatives.

Often, root causes for the lack or underperformance of using impact investment for development as well as financial goals lie not in the demand-supply transactions but in interconnected functions. For example, coordination between private enterprises and public agencies for a better enabling environment. By creating new and diverse opportunities to support essential development needs, development organisations and their impact investing partners can deliver more sustainable benefits for poor and disadvantaged women and men, creating an environment of increasing resources flowing to solve the world’s most challenging problems.

Impact investment has its own share of key challenges, including navigating policies of local governments, continuously addressing risk tolerance of investment firms, working in informal markets and measuring impact.

Additional sources:

• A How-To Guide for Blended Finance
• Impact Investing Trends Evidence of a Growing Industry
• The INGO Value Proposition for Impact Investing
• On systemic approach: what it is and what it is not

[1] How-To Guide for Blended Finance, OECD, http://www3.weforum.org/docs/WEF_Blended_Finance_How_To_Guide.pdf

[2] The INGO value proposition for impact investing: https://www.insidengo.org/sites/default/files/amplifyreport.pdf

[3] The INGO value proposition for impact investing: https://www.insidengo.org/sites/default/files/amplifyreport.pdf